Fitch joins S&P in downgrading J.C. Penney on turnaround uncertainty

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UPDATE: September 19, 2019: Fitch Ratings downgraded J.C. Penney's credit rating deeper into junk territory, to CCC+ from B-. The downgrade was based on "continued market share losses and declining EBITDA, with lack of visibility for a material turnaround although there are no near-term liquidity concerns," analysts said in an emailed report.

Analysts also described Penney's capital structure as "untenable" but noted it has the liquidity to fund seasonal working capital and near-term debt maturities. They also expect Penney's store traffic and core apparel sales to keep sliding. Fitch joins S&P in downgrading the department store retailer after a second quarter that showed continued sales declines.

Dive Brief:

Ratings firm S&P Global downgraded J.C. Penney's corporate credit rating to CCC from CCC+ following sales declines at the department store chain in the second quarter, according to a report released Wednesday and emailed to Retail Dive.

S&P analysts said in the report that Penney's capital structure "appears unsustainable over the long-term," making the risk of an out-of-court distressed debt exchange greater and prompting the downgrade deeper into distressed territory.

The analysts also said in the report that macroeconomic factors will likely become more challenging for Penney over the next year. The downgrade comes about a month after Fitch added Penney to its loans of concern list, indicating a relatively high risk of default on a $1.6 billion loan, and a few months after S&P downgraded the retailer to CCC+ in March.

Dive Insight:

S&P analysts based their downgrade partly on the unlikelihood that Penney's "operating performance will materially improve before it faces sizeable upcoming debt maturities." Penney has already taken prompt and assertive action to quelch bankruptcy rumors, saying the company is not working with advisors on a filing.

That leaves some sort of deal with lenders, such as a debt-for-equity swap, as the more likely scenario. The department store retailer doesn't have any very large maturities due in the near term, and analysts by and large see Penney as having enough liquidity to cover its obligations for the time being.

And some good news: In Q2, the retailer posted an increase in adjusted EBITDA for the first time in more than two years, according to Debtwire analyst Philip Emma, as well as a drop in inventory levels, a hedge against markdowns.

Emma said in a client note emailed to Retail Dive that Penney's Q2 report "should allay, at least for the time being, any lingering concerns that a bankruptcy is imminent." He added, though, that despite this "positive first step in rebuilding the business, it is only one quarter, and there are some aspects of the quarter's performance that warrant caution before concluding it has fully turned the corner."

The department store sector is as tough to operate in as ever. Even financially healthier players like Macy's and Nordstrom have sputtered in their performance in recent quarters, while large players like Walmart, Target and Amazon post strong growth as mall-based players have suffered. With customers already value-focused — shifting much of their purchasing to off-price and other discount players — a possible recession could exacerbate department store woes.

"It is not clear that JCP will be able to achieve sustained material benefits from its plan to transform the company into a differentiated and desirable customer destination in the next year given its competitive headwinds," S&P analysts said in the report. They also noted that its store and digital capabilities lag those of Macy's and Kohl's. Moreover, Penney's debt load and constrained cash make catching up that much harder.